This happened to me once.
I was excited for the Marvel movie ‘Thor: Love and Thunder’ and was obsessed to book the ticket for the first day first show set.
And I did!
Have to say I just got lucky to get that precious ticket.
But on 8 th July, I caught cold.
Even though I was sick, I decided to go watch the movie because otherwise “I would have wasted my money on the tickets!”.
Initially I thought I saved by watching the movie despite falling sick!
Instead, I just fell for the sunk cost fallacy!
In this blog article, we will discuss about what is a sunk cost fallacy and why is it important to understand.
This behavioral concept which affects the decision making might not always comes handy for deciding to watch a movie but might also influence huge decisions.
What is a Sunken Cost?
A cost which is Sunken!? A Sunk cost is a permanent cost that have been incurred and cannot be recovered. It is like ordering a product from Amazon without return policy and dealing with it even if you can’t return it! Unlike the expenses in monetary terms, the expense can be in the form of time, money, or asset. Let’s understand this better with an example, your college tuition fees is sunk cost.
Why?
This expense for you cannot be recovered, irrespective of whether you get a college placement in your final year or not.
Why?
What hinders the individual from making pure rational decisions?
Emotions!
These emotions seem to trigger in an exponential wavelength when it comes to investing. When an investor makes an investment into a choice, the he/she likely feels guilty or regretful. There is a constant self-doubt triggering low confidence levels which will not allow us to follow-through on that decision. Commitment bias is to blame for the sunk cost fallacy game. Committing to decisions and sticking with it until the goal is achieved! Instead, we continue to imitate the actions of the past despite new evidence suggesting that it isn’t the best course of action.
Have you ever booked a movie ticket by just watching the trailers and with taking hints from the spoilers?
I have been there, tried it and, after 30 minutes into watching a movie this experience had turned awful!
But did I not continue to watch it anyway?
I watched it till the end, till the credits of the movie.
Why?
All thanks to the sunk-cost fallacy!
At such circumstance what happened to me? I continued wasting time in watching a boring movie since I have already paid for the tickets. And moreover, I had invested 30 minutes of our time into it already. Let’s look at another example out of my experience, I’m usually awestruck by the way food is represented in the posters and eat it even though I don’t like, simply on the grounds that I have just purchased that food and can’t deny that sunk cost.
Does this happen with you too?
Similarly, getting attracted to overeating after ordering food in restaurants just because a food order has already been placed, is also a case of sunk cost fallacy.
A quick highlight here is that, not all previous expenses are sunk costs. Therefore, one must be prepared looking at the historic details but decide according to the recent conditions. Consider this, you purchased a jeans from an online store and it doesn’t fit you trying it on. Be that as it may, as the jeans is still within the return period of 30 days, here, you can return the shoe and still get back your money.
This isn’t a ‘sunk cost’.
What is this Dilemma?
The sunken cost is a situation which leads to intense confusion for decisions! Deciding whether to proceed with a particular logical acclaim or deal in which you have invested money, time and energy after a saturations point seems confusing and eventually it feels to scrap the plan!
This is because the ideal outcomes have not been in favor of accomplishments or because the project was to be shady in the past.
The problem sets in when the individual can only, with significant effort, leave the project as he has just invested a ton of money, time, and energy.
But this doesn’t just stop here.
The problem just continues when the individual starts expecting different outcomes for the same situation even though he has done nothing differently! And then incessantly, pouring more money, time, energy and resources into the task additionally, wouldn’t really be a smart move because the results are mostly unpredictable now! This dilemma of deciding whether to continue further or to terminate is known as the sunk cost dilemma.
One good example of sunk cost dilemma is a bad marriage.
Couples find it hard to decide whether to spare themselves by separating when they are know deep down that time won’t mend anything further instead it worsen the situations.
I bought a new paint for our house. I thought it would look good, but after painting two rooms with it I’ve decided it’s not meeting my
expectations! But I have already spent money on paint and have already started painting the house.
Now the only option I have if I have not fallen for sunk cost fallacy is to not wind up in the sunk cost dilemma.
Do you buy a new color to paint?
Or paint the rest of our house with this color and think there is more that liking the color that I paint?
Painting and Re-painting house is fine, what about your investments?
What if you fall for Sunken Cost Fallacy while investing?
Trust me, it would be a nightmare! The trouble of deciding whether to continue with an investment or desert it when the time and cash
have been spent and the ideal outcomes have not yet been accomplished.
The Sunk Cost Dilemma is additionally called the Concorde Fallacy.
Consider an example, suppose an investor purchased a stock at Rs 1000. Later down the line the cost of that stock starts declining. To save his portfolio for the losses, the investor averages out the purchase price by acquiring more stocks even when the cost continues to fall. This dilemma happens when the stock continues to fail to meet expectations for an extended period. In such a case, the investors emotions stating impacting the decision making and the question whether they should book the loss by selling their stocks, or should they keep averaging out with the expectation that they may recover the losses later.
In most cases, it is also seen that individuals forcefully purchasing or selling in risky stocks whenever they have faced some significant losses in the past, to nullify their investments on those losses. Whatever be the safe edging technique/strategy, the losses have already occurred, and investing in
dangerous stocks to cover those losses won’t benefit the investors anyways. Is there a better plan?
The plan will be to pick the stocks which has a higher probability to give the most ideal returns.
And not the nonexistent forceful returns that they hope to coordinate with the sunk expense. As a savvy investor, individuals should ‘not’ think about sunk expenses while settling on their choice.
Nonetheless, this is an occasionally case.
Conclusion:
There is no denying that everyone wants to become rich and make exponential profits.
Losses haunts investors, it impacts their future choices.
In any case, one must not think about sunk costs while arriving on a decision.
As sunk costs can’t be recovered, a balanced individual should disregard them while making their
decisions.
Hence, if you think you need to continue, keep your emotional quotient on continuous check!
Analyze and evaluate whether the deal is beneficial for what’s to come.
If not, terminate!
Don’t think much about it, it is better to suspend that investment.
It is advisable to attempt to estimate the future with the worst highest probabilities and then
respond accordingly!
At any point of time, there are techniques and strategies to overcoming the sunk cost conundrum by taking step by step successes over the huge ones and expanding your choices by inflating your horizons and scrapping the unfit plan of action whenever necessary which will help in cutting the
losses. If you think you are stuck in this dilemma, it is advisable to attempt to make the least misfortunes taking one step at a time by choosing the less risky alternatives and safer investment options or by seeking profession help or by starting to invest with the help of a Digital fund Manager and an
Artificial Intelligence.
Think again!